What this lesson teaches
I can describe taxes, subsidies, price controls and quotas as ways a government intervenes in a market.
Syllabus 8843, 2.1.3(a). Government Intervention in Markets: Governments may intervene in markets in the form of taxes, subsidies, price controls (maximum and minimum prices) and quantity controls (quotas)
Make a guess
The government sets a minimum price for rice above the market price, and does not buy any rice. What happens to farmers' total revenue?
- It must rise, because each tonne now sells for more.
- It may fall, because they sell fewer tonnes at the higher price.
- It stays the same, because farmers sell the same rice at a slightly higher price.
Show the answer
It may fall, because they sell fewer tonnes at the higher price.
Farmers only earn on what buyers actually buy. A higher price cuts quantity demanded, and the unsold surplus earns nothing.
A minimum price above equilibrium creates a surplus, and sellers may earn less, not more.
A minimum price (price floor) is a legal lower limit on the price. It only has an effect if it is set above the equilibrium price. It is often used to support farmers' incomes.
At the higher price, sellers want to sell more (Qs) but buyers want less (Qd). The gap is a surplus.
Only Qd units are actually bought. So producers' revenue may fall: they get a higher price but sell fewer units. Unsold output may be wasted.
To prevent this, a government may buy the surplus. That supports producers but costs public money, and the stock has to be stored or disposed of.
- Binding
- Only if set above equilibrium.
- Result
- Surplus; only Qd is sold.
- If government buys the surplus
- Supports producers but costs public money.
Why minimum prices cause problems
Surplus
Unsold output is wasted, or bought and stored by the government.
Consumers
Pay more and buy less.
Efficiency
Resources stay in production that buyers do not want at that price.
Worked example: An $8 minimum price for rice
Without intervention, 80 tonnes a day sell at $6. At $8, farmers offer 120 tonnes but buyers want only 40.
- The surplus is 120 - 40 = 80 tonnes a day.
- Only 40 tonnes are sold. Farm revenue falls from $6 x 80 = $480 to $8 x 40 = $320.
- If the government buys the 80-tonne surplus at $8, it spends $640 a day, and farm revenue rises to $960.
- That spending has an opportunity cost: the money cannot go to schools or hospitals.
Watch out for this
At a minimum price, revenue is the price times quantity supplied.
Producers only earn revenue on what is bought. Use quantity demanded, unless the government buys the surplus.
Check your understanding
A price floor on rice is set at $1,200 a tonne. At that price buyers want 800 tonnes and farmers offer 1,100. How much is traded, and how much is left over?
- 800 tonnes are traded and 300 tonnes are left unsold.
- 950 tonnes are traded, halfway between the two plans.
- 1,100 tonnes are traded, and buyers have to take the extra.
Show the answer
800 tonnes are traded and 300 tonnes are left unsold.
Right. Buyers decide how much is bought at the floor. The other 300 tonnes are the surplus.